Germany’s unilateral ban on some
kinds of naked short-selling failed to achieve the government’s
aim of keeping asset prices from falling and succeeded only in
impeding markets, the International Monetary Fund said.

“Market efficiency and quality in fact deteriorated
substantially following the introduction” of short-selling bans
in Germany and other European Union countries, the Washington-
based IMF said in a report published yesterday and posted on the
fund’s website.

The ban by Chancellor Angela Merkel’s government, issued
overnight on May 19 by the BaFin financial regulator, “did
relatively little to support the targeted institutions’
underlying stock prices, while liquidity dropped and volatility
rose substantially,” the IMF said.

Merkel invoked “a battle of the politicians against the
markets” and labeled speculators “our adversaries” as her
government prohibited naked short-selling of bonds, credit-
default swaps on euro-area government bonds and stocks of German
companies. The decree, made as European governments and the IMF
hammered out a $1 trillion bailout package to arrest a debt
crisis emanating from Greece, sent stocks around the world
sliding. Parliament anchored the decree in law last month.

There’s no strong evidence that short selling led to
falling prices during the crisis, the IMF said. Most of the
“adverse market movement can be attributed to fundamental
factors and to uncertainty due to partial or inadequate
disclosures.”

‘Unnecessarily Distortive’

The report adds to criticism that the German regulation is
too far-reaching and misses the point. The IMF said it favors a
more harmonized approach to short-selling regulation in the EU
as “go-it-alone approaches are unnecessarily distortive and
inadequately effective.”

“The Finance Ministry doesn’t see the IMF report as a
direct criticism of Germany,” ministry spokesman Bertrand
Benoit said by telephone. “We made it clear from the beginning
that we would be ready to modify legislation to bring it in line
with EU-wide legislation.”

Credit-default swaps are derivatives that pay the buyer
face value if a borrower -- a country or a company -- defaults.
In exchange, the swap seller gets the underlying securities or
the cash equivalent. Traders in naked credit-default swaps buy
insurance on bonds they don’t own. Naked short selling involves
selling a security without ever being in possession of it.

Sarkozy Joins In

While Merkel was initially isolated on the short-selling
ban, French President Nicolas Sarkozy later joined her in
calling on the EU to speed up curbs on financial speculation.

The EU plans to propose new rules on short selling next
month, Financial Services Commissioner Michel Barnier said in
June. The commission, the EU’s executive agency, is reviewing
comments from industry groups before making any proposals.

The European Commission’s proposal is a “good first step
towards a common framework,” according to the IMF.

“We agree with the Commission that short selling generally
fulfills a valuable role in financial markets, and should be
possible,” it said. Short selling “augments market liquidity,
increases trading volumes and serves as a signal to discriminate
perceived strong from weak firms or sovereigns.”

Still, effective supervision and enforcement as well as
enhanced transparency, “margining” and collateralization
should be employed to contain risks from market abuse and
deliberate failures to deliver the shorted securities, it said.

The Association for Financial Markets in London, which
represents banks including UBS AG and Deutsche Bank AG, said
July 12 that the commission’s proposals to make investors
disclose short positions at low thresholds are “unfair.”